Updated: April 28, 2020
Accounting is a part of any business and as a business owner, you should be able to know at least its basic terms and concepts.
When I started my first business, I had no accounting background. I thought that I really didn’t need to know anything about it.
I said to myself, is it really necessary to learn accounting? Isn’t it just a matter of making sure that the business is earning more than what it is spending?
A few months into the business, I started to realize how wrong I was. I actually needed to know basic accounting to run the business. I especially struggled with the terms and legalities involved in filing taxes, insurance, loan applications, among others.
That’s when I decided to hire a freelance accountant to help me. And from that moment on, I began to understand how important it really is to have some basic knowledge of accounting for your business.
Here are some of the things I’ve learned through it all. I hope that by sharing with you some of these basic accounting terms and concepts, I can clear some of the confusing jargon you’d often encounter in business accounting.
Debit and Credits
All business transactions are recorded as either a debit or a credit. A debit “adds value” to an account while a credit “removes value” to an account.
Accounts
What is an account? It is the area or item where value (i.e. money) comes in or out. For example, your bank savings account.
Furthermore, when you make a cash deposit, then that is considered a debit transaction. When you withdraw money, then you’re making a credit transaction to your savings account.
Assets, Liabilities, Equity, Revenue and Expenses
These are the different types of accounts in a business or accounting system.
Assets – things that the business owns such as cash on hand, the value of equipment and machinery, future money collections, intellectual properties, and many others.
Liabilities – the opposite of assets, these are financial obligations of the business such as bank loans, credits to suppliers and so on.
Equity – also called the owner’s equity. At the most basic, this is assets less liabilities and represents the net worth of the business. Equity can also refer to the amount of money invested into the business.
Revenue – this is the account that tracks the income of the company such as product sales, service fees, and commissions.
Expenses – the opposite of revenue. This is the account that tracks the costs of generating the income for the business such as salaries, utility bills, depreciation, rent and others.
The General Ledger and Accounting System
All these business accounts are listed in the general ledger. Nowadays, many businesses use a computer accounting system software to track its accounts.
The Accounting Equation
The accounting equation states that the sum of the assets and expenses must be equal to the sum of the liabilities, equity, and revenue of the business.
This is the equation that the general ledger or an accounting system must keep balanced. In mathematical equation it is:
Assets + Expenses = Liabilities + Equity + Revenue
By ensuring that this equation ALWAYS holds true for your business, you then have the guarantee that all business transactions were properly accounted for. Accounting is as simple as that.
So for example, let’s say you borrowed P10,000 from a friend. Then you used that money and P2,000 of your personal cash to buy 100 pieces of an item that costs P120 each.
After which in just one day, you were able to sell 30 pieces of that item for P180 each at a bazaar stall, which rents for P200 a day. Then your accounting equation at the end of the day will somewhat look like this:
Please understand that these are all very basic and simplified explanations. If you want to know more about small business accounting, I suggest that you take a short course in a business training institution. You can also read books and online references, or consult an accountant.
Moreover, you might be interested to read my previous article on how to calculate your net worth. Doing this will help you practice some of the basic accounting terms and concepts you just learned. And at the same time, help you discover where you are in your financial road map.
If you want to learn more about money, business and personal finance, then please subscribe to Ready To Be Rich.
Great article Fitz. I remember I attended a seminar for “Accounting for non-accountants at the office many years ago but I didn’t appreciate it very much then. Now, accounting is something I can’t do without and I started using MS Money to help me with this more than a year ago to keep track of everything, but I will have to consider hiring an accountant soon. Thanks for the very informative article!
Thanks for sharing about your learning curve in this area.
I wanted to recommend the best book I’ve found for small business accounting — Radical Accounting by Madeline Bailey. She writes in a common sense way, with real life examples and even a sense of humor. She covers all the basics and really emphasizes maximizing use of your reports to make better profit.
Please publish a book with your articles 😀
@Jay
We have a similar experience. I was also able to attend an accounting seminar in my office back then and I didn’t appreciate it until I resigned and became an entreprenuer. 😀
@Debbie
Wow, thanks for the book recommendation. I’ll try to search for that book myself.
@Micamyx
I’m actually thinking about that. But not now, hopefully by next year. 😉
Hello, nice website you have here. I am also building my E-learning MBA master degree at http://learningmbamasterdegree.blogspot.com
Shall we do a link exchange ?
Hi Fitz!
Thank you for sharing basic accounting lesson…I’m just wondering where the cash on hand value(5,200) in your example came from? untill now i’m still thinking about that 🙂
Hi Anne,
P5200 = P5400 – P200 : That is your gross sales (P180 x 30 pieces) less the rent (P200) 🙂
Hi Fitz, this is a great article to start from for new entrepreneurs. I suggest that they invest on buying book that Accounting students are using, its called Accounting 1/2 or Basic Accounting book of any authors its okay. They can ask in National Bookstore or if they want cheaper just go to Recto along university belt. For accounting student, its essential that this Accounting basics are fully understood. This book is one of the most important foundation of accounting courses. It will cost you only less than 500 pesos and its handy whenever you need it.
Just remember, RECORD every sales and payments you receive and expenses that you spend relating to your business. Write it first in your own terms and search in the book the related Chart of Accounts. And start from that first step.
Goodluck everybody!!
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I am outsorcing my company accounts to 3rd party charter accountant company. Actually my wife is doing book-keeping for the company and I just check out before we send for check up. I imagine it is rather easy as soon as you have the right program.
can you teach me in basic accounting? if we started our discussion, i might ask you something that I don’t know. thanks!
this is really helpful even though i’m starting to advance learning on what accounting is , i just read it and have a little bit knowledge about it ! 😀 thank u and godbless
[…] hired an experienced cook to run his kitchen. He also has an accountant in his payroll who takes care of his books. And a cafeteria manager to supervise everyone, […]
I like it this way – simple. Your explanation sounds good to me! I am intimidated to take accounting courses for fear of not understanding anything. Anyway experience is the best teacher!
[…] hired an experienced cook to run his kitchen. He also has an accountant in his payroll who takes care of his books. And a cafeteria manager to supervise everyone, […]